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Option exercise with temptation

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  • Jianjun Miao

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Abstract

This paper analyzes an agent¡¯s option exercise decision under uncertainty. The agent decides whether and when to do an irreversible activity. He is tempted by immediate gratification and suffers from self-control problems. This paper adopts the Gul and Pensendorfer self- control utility model. Unlike the time inconsistent hyperbolic discounting model, it provides an explanation of procrastination and preproperation based on time consistency. When applied to the investment and exit problems, it is shown that (i) if the project value is immediate, an investor may invest in negative NPV projects; (ii) if the production cost is immediate, a firm may exit even if it makes positive net profits; and (iii) if both rewards and costs are immediate, an agent may simply follow the myopic rule which compares only the current period benefit and cost.

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File URL: http://hdl.handle.net/10.1007/s00199-006-0194-3
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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 34 (2008)
Issue (Month): 3 (March)
Pages: 473-501

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Handle: RePEc:spr:joecth:v:34:y:2008:i:3:p:473-501

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Related research

Keywords: Time (in)consistency; Self-control; Temptation; Procrastination; Preproperation; Real options; D81; D91; G31;

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References

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  1. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. DeJong, David N. & Ripoll, Marla, 2007. "Do self-control preferences help explain the puzzling behavior of asset prices?," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1035-1050, May.
  3. Stefano DellaVigna & M. Daniele Paserman, 2005. "Job Search and Impatience," Journal of Labor Economics, University of Chicago Press, vol. 23(3), pages 527-588, July.
  4. Faruk Gul & Wolfgang Pesendorfer, 2001. "Temptation and Self-Control," Econometrica, Econometric Society, vol. 69(6), pages 1403-1435, November.
  5. Susanna Esteban & Eiichi Miyagawa & Matthew Shum, 2003. "Nonlinear Pricing with Self-Control Preferences," Discussion Papers 0304-03, Columbia University, Department of Economics.
  6. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  7. David K. Levine & Drew Fudenberg, 2006. "A Dual-Self Model of Impulse Control," American Economic Review, American Economic Association, vol. 96(5), pages 1449-1476, December.
  8. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 2003. "Time-Inconsistent Preferences And Social Security," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 745-784, May.
  9. Steven R. Grenadier & Neng Wang, 2006. "Investment Under Uncertainty and Time-Inconsistent Preferences," NBER Working Papers 12042, National Bureau of Economic Research, Inc.
  10. Matthew Rabin & Ted O'Donoghue, 1999. "Doing It Now or Later," American Economic Review, American Economic Association, vol. 89(1), pages 103-124, March.
  11. Per Krusell & Anthony A. Smith, Jr., 2003. "Consumption--Savings Decisions with Quasi--Geometric Discounting," Econometrica, Econometric Society, vol. 71(1), pages 365-375, January.
  12. Brocas, Isabelle & Carrillo, Juan D, 2001. " Rush and Procrastination under Hyperbolic Discounting and Interdependent Activities," Journal of Risk and Uncertainty, Springer, vol. 22(2), pages 141-64, March.
  13. W. Pesendorfer & F. Gul, 1999. "Self-Control and the Theory of Consumption," Princeton Economic Theory Papers 99f2, Economics Department, Princeton University.
  14. Ted O' Donoghue & Matthew Rabin, 2001. "Choice and Procrastination," Microeconomics 0012002, EconWPA.
  15. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., 2000. "Temptation and Taxation," GSIA Working Papers 2001-12, Carnegie Mellon University, Tepper School of Business.
  16. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  17. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  18. Krusell, Per & Kuruscu, Burhanettin & Smith, Anthony Jr., 2002. "Time orientation and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 107-135, January.
  19. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 443-77, May.
  20. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, University of Chicago Press, vol. 14(2), pages 189-99, September.
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Citations

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Cited by:
  1. Fudenberg, Drew & Levine, David, 2006. "A Dual-Self Model of Impulse Control," Scholarly Articles 3196335, Harvard University Department of Economics.
  2. Houser, Daniel & Schunk, Daniel & Winter, Joachim & Xiao, Erte, 2010. "Temptation and Commitment in the Laboratory," Munich Reprints in Economics 19377, University of Munich, Department of Economics.
  3. Klaus Nehring, 2006. "Self-Control through Second-Order Preferences," Levine's Bibliography 321307000000000391, UCLA Department of Economics.
  4. D.Dragone, 2005. "Incoerenza Dinamica ed Autocontrollo: Proposta per un'Analisi Interdisciplinare," Working Papers 549, Dipartimento Scienze Economiche, Universita' di Bologna.
  5. Kyle Hyndman & Alberto Bisin, 2009. "Procrastination, Self-Imposed Deadlines and Other Commitment Devices," Departmental Working Papers 0904, Southern Methodist University, Department of Economics.
  6. Tsvetan Tsvetanov & Kathleen Segerson, 2011. "Re-Evaluating the Role of Energy Efficiency Standards: A Time-Consistent Behavioral Economics Approach," Working papers 2011-24, University of Connecticut, Department of Economics.
  7. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  8. Hsiaw, Alice, 2013. "Goal-setting and self-control," Journal of Economic Theory, Elsevier, vol. 148(2), pages 601-626.
  9. Tsvetanov, Tsvetan & Segerson, Kathleen, 2013. "Re-evaluating the role of energy efficiency standards: A behavioral economics approach," Journal of Environmental Economics and Management, Elsevier, vol. 66(2), pages 347-363.
  10. Isao Shoji & Sumei Kanehiro, 2012. "Intertemporal dynamic choice under myopia for reward and different risk tolerances," Economic Theory, Springer, vol. 50(1), pages 85-98, May.

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